RSS

Resource Center

When Are Fixed Annuities the Right Choice?

Fixed annuities, issued by insurance companies, are similar to CD investments insofar as they pay guaranteed rates of interest, and can help to stabilize retirement income. Retirees or soon-to-be retirees most commonly purchase fixed annuities, which guarantee stable payments starting at a certain designated age. These annuities are typically either purchased with a one time, lump sum payment or through consistent installments while the annuitant, an individual who owns an annuity, is still working. There are two types of fixed annuities, deferred and immediate annuities.

With deferred fixed annuities, the account collects money and grows – tax-deferred – during the accumulation phase. Once the accumulation phase ends, annuitants can begin to receive payments, either through one large payout or through smaller, monthly payouts.

Immediate fixed annuities, on the other hand, disburse payouts immediately. Investors typically start to receive regular payments as soon as 30 days after investment. Once the payments begin,  most do not increase regardless of inflation or in the case of an unexpected event. Although, some annuities offer an annual percentage increase in the income payment to help offset inflation. Also, annuitants who start receiving immediate fixed annuity payments no longer can access, the original principle.

Essentially, the main difference between immediate fixed annuities and deferred fixed annuities is whether or not the annuitant desires immediate income, or instead prefers to build his or her account value over time for future income.

Types of Fixed Annuities

Two main fixed annuity categories exist, life annuities and term certain annuities, with the former containing multiple product variations. With life annuities, the annuitant receives a predetermined, fixed amount paid periodically until his or her death. Therefore, it is considered a form of longevity insurance. The different types of life annuities include:

Life Annuities

1) Straight Life Annuities

Straight life annuities provide the annuitant with a fixed payout amount until his or her death, and this type of life annuity does not offer any sort of payout to surviving beneficiaries. Straight life annuities may be purchased with payments made over the course of the annuitant's working career, or they may be bought towards retirement with a lump sum.

2) Substandard Health Annuities

Substandard health annuities are solely for individuals with life-threatening health conditions whose life expectancies are shortened as a result. Annuitants typically receive higher payouts per period with this type of annuity because of their shorter life expectancies. However, substandard health annuities are also more expensive to purchase.

3) Life Annuities with Guaranteed Terms

Life annuities with guaranteed terms differ from straight life annuities because they allow annuitants to add beneficiaries to their policies. If the annuitant should die before their policy expires, then their designated beneficiaries will receive any money that has not yet been paid out.

4) Joint Life with Last Survivor Annuities

Joint life with last survivor annuities allow payouts to be continued to the annuitant's spouse if he or she should die. Adding a “Period Certain” provision, guarantees the monthly income payments to designated beneficiaries for a defined period of time.

Term Certain Annuities

The second category, term certain annuities, guarantees a predetermined, fixed payout over a specified term. This means that once the term agreement has expired, regardless of whether or not the annuitant is living, all payouts will end. If the annuitant should die before his or her policy ends, the insurance company keeps the remainder of the annuity’s worth.

If the annuitant's living expenses increase, their payouts will still remain the same. Due to term certain annuities' limiting options, they are inexpensive to purchase.

Who Should Invest in Fixed Annuities?

Generally speaking, retirees, soon-to-be retirees and/or conservative investors tend to gravitate towards fixed annuities due to their financial stability. Most fixed annuities provide purchasers with steady rates of interest and guaranteed principle amounts. Individuals who decide to invest in fixed annuities have low investment minimums ranging from $1,000 to $15,000, and the accumulated interest is tax-deferred until it is withdrawn. Those who are looking to secure their retirement nest eggs with stable income benefit most from investing in fixed annuities. Furthermore, individuals who wish to pass their assets onto their beneficiaries without probate should also consider investing.

Who Should not Invest in Fixed Annuities?

Individuals who are either too young or who are looking for short term investments should avoid investing in fixed annuities. Any annuity income that is withdrawn before age 59.5 is subject to a 10% IRS tax penalty. Therefore, fixed annuities should be planned so that income collection starts at age 60 or thereafter. Fixed annuities, with the exception of immediate fixed annuities, are also not ideal short term investments because they are not as liquid as stocks or bonds, and should therefore only be used for retirement funds.

The Advantages of Fixed Annuities

For those who are ideal candidates, fixed annuities offer a number of distinct advantages, including:

• Most fixed annuities are tax deferred, which means that investors are not required to pay tax on any earnings until they begin to withdrawal.  Investors end up earning additional interest compounding on the money that would have normally gone toward taxes.

• Unlike many investments, fixed annuities have no upfront sales charges or administrative charges. One hundred percent of the money goes to work right away.

• Currently, most fixed annuities offer competitive interest rates, often offering better rates than comparable bank CD’s. Some of them also provide additional benefits that stocks, mutual funds and other investments lack.

• Proceeds can be paid directly to a named beneficiary and may avoid the expense and delay of probate.

• Certain fixed annuities can guarantee retirement income for the entirety of the annuitant’s life, which means that they will never have to go back to work. Similar investments are unable to guarantee a fixed income until death.

• Some annuities also offer special benefits that allow for increased income should the annuitant become disabled. This aids in covering the costs of any additional medical care.

• Some annuities offer special withdrawal provisions that may be available to help in the case of confinement to a nursing home.

Fixed Annuity Drawbacks and Pitfalls

Although fixed annuities have the advantages of providing stable retirement income along with select insurance options, they also have a number of disadvantages – including pitfalls – which potential investors should be cautious about. These include:

• Some annuities have limited time fixed interest rates, which means that after a certain specified time, rates could decrease. If an annuitant does not approve of the new rates and withdrawals his or her money early, he or she could face heavy surrender charges.

• For individuals who choose fixed lifetime payments, those payments will not increase to compensate for higher living costs. This means that the value of money received will decline over time due to inflation.

• Once annuity money is withdrawn, individuals must pay federal, state and local income taxes. If an annuitant decides to receive a lump sum payment, it could be taxed as ordinary income, which means that he or she would not receive a capital gains tax break.

• Investors risk facing the possibility of lower returns on their investments in exchange for retirement income stability. This is because fixed annuities are conservative investments, unlike stocks, which fluctuate in value and have the capacity to gain significant earnings.

• Some fixed annuities, like immediate fixed annuities, do not allow investors to access their principle, which means that investors need to be committed to investing in those annuities.

Fixed Annuities: All Things Considered

Overall, fixed annuities can be a wise investment for retirees or soon-to-be retirees who are looking for conservative, long term investments. Fixed annuities offer stable income, guaranteed rates of interest, and even insurance options. Because of the many different types of fixed annuities on the market, investors are almost guaranteed to find one that fits their needs. However, potential investors should be mindful of the type of fixed annuity they choose, and the terms of the contract that they sign.

Disclaimer

Annuities are not a deposit in any bank. They are not FDIC insured by any Federal Government Agency. Guarantees are based on the claims paying ability of the issuing company. The guarantees of an annuity contract, including fixed returns, payouts, and death benefit guarantees are contingent on the claims-paying ability of the issuing insurance company. The principal amount of payments of an annuity purchased with funds from a qualified retirement plan may be taxable. With either systematic withdrawals or free withdrawals you will still be subject to regular income taxes, as well as the 10% tax penalty on early withdrawals prior to age 59 1/2. You may also incur surrender charges on amounts withdrawn in the early years of the contract.